HABIT FORMATION AND LONG-TERM-CONTRACTS

It is often assumed that the consumption of certain goods causes changes in preferences: The more we consume these goods, the more we like them. Extreme examples of such habit-forming goods are drugs (from heroin to cigarettes); mild examples are sweets, books, and sports. The process of habit formation is usually described as the accumulation of a certain form of "human capital" which is introduced as a variable in the utility function. As such, habit formation is regarded as similar to the technologically necessary joint consumption of capital goods and variable inputs: heating system and fuel, video-recorder and video-tape, etc. By developing a certain capital stock, an individual - or an economy - becomes dependent on or addicted to a certain complementary input. This paper contains a discussion of reasons why long-term contracts for habit-forming goods are concluded. Furthermore, it is investigated which form such contracts should have. This helps us to understand the frequent appearance of Take or Pay contracts in the energy markets as well as in book clubs, fitness centres, language courses, etc. © 1990 Kluwer Academic Publishers.